Premier Insights, Inc. conducted a financial and strategic study of Crestview Farm Credit Association (CFCA). The report details CFCA's declining financial performance, attributing the issues to poor credit quality, economic downturn, and operational weaknesses. The study evaluates several strategic alternatives for CFCA, including maintaining the status quo, mergers/acquisitions, and a return to a traditional agricultural lending model. The report concludes that a return to a traditional model with significant internal changes is the most favorable option, although a merger is also considered viable. Finally, the report includes projections for CFCA's financial performance under different scenarios.
The information in this case study is based on the provided report and is intended to illustrate Premier Insights, Inc.'s analytical capabilities. The names of the financial institution and market areas have been changed for confidentiality purposes.
Introduction
Premier Insights, Inc. (PI) was engaged by Crestview Farm Credit Association (CFCA) to conduct a comprehensive financial and strategic study. CFCA, like many financial institutions, was facing significant challenges due to economic downturn and credit quality issues. This case study illustrates how Premier Insights, Inc. provided a detailed analysis of CFCA's situation, identified key challenges and opportunities, and developed strategic alternatives for the organization's future.
Background
Crestview Farm Credit Association, a long-standing agricultural lender with a reputation for innovation, experienced a softening of performance conditions. A financial analysis revealed critical weaknesses in key performance indicators, threatening the institution’s ability to operate effectively. A core component of the study was to analyze the current state of CFCA and develop strategic alternatives. The study did not include an independent review of credit quality, as this was being handled by another contractor, and relied upon the credit quality and audit reports provided by the association.
Key Performance Indicators and Underlying Trends
PI identified that CFCA's challenges were primarily due to credit quality issues, similar to other financial institutions under stress nationwide. The composition of CFCA's portfolio and the economic climate put the institution's capital, risk-bearing capacity, earnings, and liquidity at risk. Specific challenges included:
- A Return on Assets (ROA) of 0.42%, significantly below the average ROA of 1.13% for the other Four Central Farm Credit (4CFC) Associations.
- Non-accrual Loans to Gross Loan Items was 8.2%, the second-highest among the 4CFC’s.
- Allowance for Loan Losses to High-Risk Assets was 8.77%, the lowest among the 4CFC’s, while the average for other 4CFCs was 22.43%.
- Nonperforming assets as a percent of risk funds stood at 45%, three times that of peer associations.
- The percentage of loans in non-accrual status was four times higher for CFCA relative to peers, and the percentage of delinquent loans was three times higher.
- CFCA ranked in the 94th percentile for charge-offs relative to total loan volume.
- Loans classified as substandard or worse were equal to 75% of risk funds, and adding loans classified as OAEM, this total represented 116% of risk funds as of February, 2010.
- Adverse assets were 79.74% of risk funds, and criticized assets were 136.8% of risk funds.
Further analysis revealed weaknesses in accountability and oversight. While CFCA had a well-developed business plan, there was a lack of follow-through and measurement mechanisms, particularly regarding credit quality. There was also a lack of aggressive efficiency measures in response to the institution's weakening performance. Additionally, PI identified fundamental weaknesses in the association's lending function, with the volume of loans originated by the institution trending downward since.
Economic Conditions
The economic analysis covered the U.S. economy, the state of the fictional territory of Northreach, and the specific economic conditions of the ten-county fictional region of the Clearwater Association Area.
U.S. Economy: The U.S. economy was in a state of fragile recovery, with some positive indicators such as increasing consumer confidence and positive earnings reports. However, high unemployment levels persisted, and the labor market faced challenges, including job losses and wage stagnation. The global economy was also affected by the Euro crisis, which could potentially impact the U.S. economy through contagion and inflation. Longer-term concerns included government spending, potential inflation, and new taxes, which could hinder economic growth.
Northreach Economy: The Northreach economy, like other areas, was significantly affected by the bursting of the housing bubble. The state experienced high unemployment rates and a backlog of foreclosures. However, there were hopeful signs, including smaller declines in real estate values and increased sales tax receipts. The Northreach economy also showed strengths in tourism, foreign trade, and high-tech industries. The agricultural sector in Northreach, particularly in the Clearwater region, showed growth in dollar sales despite a decrease in acreage.
Clearwater Association Area Economy: PI conducted an in-depth analysis of the 10-county Clearwater region, focusing on population, income, employment, and real estate. Key findings included:
- Population growth slowed.
- Employment growth also slowed, with declines occurring.
- Farm income experienced a significant decline.
- Per capita incomes declined.
- Farm land acreage decreased from 2002 to 2007, with the average size of farms also decreasing.
- Despite the reduction in acreage, agricultural sales increased, indicating an increase in prices and productivity.
- Housing prices in the region experienced significant increases before peaking and then declining.
Evaluation of Strategic Alternatives
Based on the analysis, Premier Insights, Inc. evaluated several strategic alternatives for CFCA:
- Status Quo with Changes: This was deemed not viable due to the institution's reliance on a servicing portfolio that was expected to decline and capital markets participations that had proven ineffective. Operational inefficiencies also needed to be addressed.
- Merger/Acquisition: This option presented a potentially desirable alternative, but it faced challenges, such as the need for willing partners and the difficulty of merging institutions of disparate sizes. While a merger with the South Clearwater Association was considered the most attractive, the economic conditions in the state and the challenges of combining institutions with similar problems had to be considered.
- Traditional Ag Association Lender: Returning to a traditional agricultural lending model was seen as a potentially effective option, but it required some conditions. This approach would require a partial or complete sale of the servicing portfolio, aggressive cost-cutting, effective risk mitigation, addressing the problem of underwriting and closing loans and strong leadership. This also involved dealing with leadership issues.
Conclusions and Recommendations
Premier Insights concluded that CFCA’s financial situation was serious but not on the verge of collapse, given their capital position. While a merger could be an option, PI recommended that CFCA remain a stand-alone institution but make significant adjustments to their practices. These critical, non-negotiable actions included:
- Resolving the CEO issue quickly and evaluating the current management structure.
- Exploring the possibility of selling or assigning poor-quality assets.
- Revamping the lending function and credit administration to become more efficient.
- Implementing aggressive efficiency strategies immediately.
- Evaluating the servicing component in light of anticipated volume reduction.
- Implementing a credit quality and loss amelioration plan with significant controls and accountability.
Value of Services
This case study demonstrates Premier Insights, Inc.’s ability to provide a thorough and insightful analysis of a complex financial situation. Through a combination of financial, economic, and strategic expertise, PI was able to:
- Provide a deep dive into CFCA's key performance indicators, identifying the root causes of its challenges.
- Analyze the economic context at local, regional, and national levels, informing strategic decisions.
- Develop and evaluate various strategic alternatives, offering specific recommendations that took into account CFCA’s unique position.
The findings and recommendations provided CFCA with a clear path forward to address its challenges and improve its performance. The comprehensive nature of PI's analysis allowed the institution to make informed decisions regarding its future viability and strategic direction. The approach was thorough, precise and allowed the client to be aware of both the challenges, and the opportunities.